It’s all about shareholder fees, not operating costs.
The former detracts to alpha, the latter adds to it.
In fact, a paper published last summer shows that (“direct-sold”) mutual funds that spend more on management than on distribution tend to have performance returns far exceeding that of (“broker-sold”) funds whose spending is focused on distribution.
What’s more, this research concludes that performance advantage of direct-sold mutual funds erases any theoretical advantage index funds have over actively managed funds.
Of course, some economists suggest buying lower-performing funds might be justified in the case of certain investors – except for 401(k) plan sponsors. (Interested in reading more about this? It’s all spelled out in “401k Plan Sponsor Fiduciary Alert: Conflicts-of-Interest More Important than Mutual Fund Expense Ratios,” FiduciaryNews.com, January 13, 2015.)
So there you have it. After decades of claiming high expense ratios are bad, we now have empirical evidence that high expense ratios are … the wrong thing to look at!
For the most part, expense ratios represent the cost of doing business for mutual funds. They include paying for regulators, legal and accounting professionals, and professional investment management.
All these operating costs help the mutual fund protect the best interests of fund shareholders. These are all reported in the Fee Table located on Page 2 of the fund prospectus under “Annual Fund Operating Expenses (expenses that you pay each year as a percentage of the value of your investment).” This is where the fund’s expense ratio is disclosed. With two important exceptions (I’ll get to those in a second), plan sponsors should understand these are “good” fees.